Risk Returns

Overview:  Cynicism over the prospects of a resolution to US-Chinese trade tensions and a break-through in UK-EC Brexit talks appears to be injecting a more cautious tone to the capital markets.  The recovery in equities has stalled.  The MSCI Asia Pacific benchmark halted a four-day rally, and the Dow Jones Stoxx 600 Index is off marginally today after advancing every session last week.  European and Asia-Pacific bond yields were dragged higher by the sharp rise in US yields following the jobs and earnings data before the weekend, but the US 10-year yield is dipping back below 3.20%.  The dollar is little changed but mostly firmer against the major currencies, where near midday in Europe the dispersion of changes among the major currencies is less than +/- 0.15%.  Emerging market currencies are mostly lower, led by India, South Africa, Turkey, and China.  The retreat in oil prices has extended into a sixth session, but the downside momentum appears to be easing and be on-guard for a potential reversal. 


China’s President Xi did not offer fresh initiatives at today’s speech in Shanghai.  He did seem to play up ongoing plans to reduce tariffs.  There are many areas in which China could gain efficiencies by modernizing and selectively liberalizing.  Reducing some tariffs and domestic taxes may provide economic stimulus without necessarily boosting debt or leverage.   Chinese stocks finished lower, but the Shanghai Composite traded within the pre-weekend range and settled near session highs.  A gap that extends to a little above 2700 may be key to the near-term direction.  After appreciating in the last two sessions, the yuan eased by 0.5% today. 

The dollar is firm against the yen and is a little shy of last week’s high near JPY113.40.  This area is proving sticky but if and when it is surmounted it is the last significant barrier to a run at the year’s high set in early October near JPY114.55.  The Japanese economy may have contracted in Q3, but is off to a better start in Q4.  The October manufacturing PMI was nothing to write home about.  It slipped to 52.9 from 53.1 but the services sector PMI, reported earlier today, rose to 52.4 from 50.2. This was sufficient to lift the composite to 52.5 (from 50.7), which is the highest since April. Meanwhile, the BOJ’s Kuroda seemed more circumspect about the large-scale effort to overcome deflation and seemed more cognizant of the costs.  Still, the underlying problem remains the same,  The lack of much progress toward the inflation goal restricts the room to maneuver.  

The Reserve Bank of Australia meets tomorrow.  Policy is on hold with the cash rate at 1.50%.  The Reserve Bank of New Zealand, which also meets this week, seems more confident than the RBA, but it is on hold as well.  The Australian dollar bounced off the $0.7000 area tested in late October to a high at the end of last week near $0.7260 (100-day moving average is ~$0.7270).  It is straddling $0.7200.  The intraday technicals seem to favor a push lower in North America.  


Sterling opened higher in Asia amid news reports about the possibility that the UK would remain in the customs union and thereby avoid an Irish border problem.  This would be highly controversial domestically, and for many, it would make a mockery out of Brexit.  It was dismissed as speculation by UK officials, and sterling retreated. Initial support is seen near $1.2950. There is a GBP1.1 bln option at $1.2925 that will be cut tomorrow.  Meanwhile, the UK’s Brexit negotiator Raab was encouraging May to secure the right to limit the Irish backstop to three-six months rather than open-ended as the EC wants.  

Separately, just as investors digested the slightly hawkish tilt from last week’s BOE meeting, the PMIs confirm a loss of momentum.  Recall that the manufacturing PMI disappoint (51.1 from 53.6) and the construction PMI came in firm at 53.2 from 52.1, though it covers the smallest part of the British economy.  Today’s the service sector PMI eased to 52.2 from 53.9.  This brought the composite reading to 52.1 from 54.1 and is the lowest in two years and warns of a poor start to Q4.  Last year, the composite averaged 54.7.  Through September the average this year was 53.7.

The euro has been confined to about 15 ticks on either side of $1.1390, keeping it pinned near the pre-weekend lows.  There is a 1.2 bln euro option struck at $1.14 that expires today.  There is also a 1.1 bln option at $1.350 that also expires today.  There are two main developments today.  First, the Sentix investor confidence was poor and the November reading is the weakest in two years.  This is consistent with other data showing a loss of momentum, and of course, the recent weakness in equities hit sentiment.  However, the ECB is still putting emphasis on ideas that the output gap has closed and that this will boost price pressures over time.  The second development is the EU finance ministers meeting.  The focus is on Italy, which has until November 13 to respond to the EC’s demand for a revision to the 2019 budget proposals.  Then the EC has three weeks to provide a final assessment, which could begin the excessive deficit procedures.  Although ultimately Italy could be fined 0.2% of GDP, it is still more than a year away as the actual performance is key not projections.  

Turkey reported slightly a slightly larger than expected rise in the October CPI but it is unlikely to lead to a rate hike. The central bank does not meet again until December 13.  Turkey’s CPI rose 2.67% on the month, and that lifts the year-over-year rate to 25.25% from 24.52%.  The core rate edged up to 24.34% from 24.05%.   The recovery of the Turkish lira will likely begin helping easing price pressures.  Consider that the 30-day moving average for the dollar has fallen from around TRY6.30 to TRY5.81 today.  A domestic contraction now seems to be a bigger threat than the external imbalances and inflation.  The lira is trading within pre-weekend ranges though the dollar is about 0.5% stronger. 

North America   

The US reports the PMI and ISM surveys today, but the week’s highlights (mid-term election and FOMC meeting) lie ahead.  The Dollar Index is little changed.  With the help of the strong employment report and some optimism on trade helped the Dollar Index hold support near 96.00.  Initial resistance is seen now in the 96.60-96.75 area, which if overcome signals a test on the year’s high seen at the end of October near 97.20. The Canadian dollar is sidelined.  The US dollar is trading in about a 10-tick range around CAD1.3100.  

The debt markets continue to be asked to absorb increasing supply of government paper.  The weekly three and six-month bill sales will raise $84 bln today.  There are also four, eight and 52-week bill sales this week on top of the quarterly refunding that will raise another $83 bln this week (three-year and 10-year notes followed by 30-year bonds).   The S&P 500 gapped higher last Wednesday.  That gap, which extends to about 2685.4 may be key to the near-term outlook. The pre-weekend low was just above 2700.  The failure to close the gap likely would be seen as a bullish indication.   


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